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Mutual Funds: Here’s why you should approach NFOs with caution

At times NFOs are based on short-term fads which may not play out in the longer term

By: | Published: September 19, 2016 6:16 AM
Rising returns from existing funds, tighter regulatory norms and untested strategy have taken the sheen off new offerings.

Individual investors are no longer finding new fund offers (NFOs) of mutual funds enticing. Rising returns from existing funds, tighter regulatory norms and untested strategy have taken the sheen off new offerings. Till August this year, asset management companies (AMCs) have raised only R870 crore from 13 NFOs as compared to R12,200 crore from 74 offerings in 2014, data from Association of Mutual Funds of India show.

Fund houses launch equity NFOs when markets are on a roll. It is similar to initial public offerings (IPOs) of stocks where one buys the equity before it lists on the exchanges. The NFOs are offered for a limited period of time and investors get the prevailing net asset value.

However, before investing in any NFO, one must analyse the performance of earlier offerings of the AMC. Dhaval Kapadia, director, Investment Advisory, Morningstar Investment Adviser (India) says NFOs might provide exposure to a differentiated strategy/mandate (if any) vis-à-vis existing funds. “Of course, one needs to assess whether the investment strategy offered by a new fund is truly different as compared with the existing funds,” he says.

As AMCs launch NFOs with a new theme, it is difficult to analyse the future of the fund. One way to analyse the fund is to look at the performance of similar funds existing in the market and see if there is any value added in the new fund which can generate higher returns in the long-run.

Brijesh Damodaran, founder and managing partner of BellWether Advisors LLP says NFOs bring their own flavour and is more suitable for seasoned investors. “NFOs which came out in late 2013 and early 2014 have delivered returns beating the benchmark. But then for every success there are multiple failures,” he says.

In the past, fund houses used to launch a spate of NFOs to attract new investors and create excitement in the market. However, the markets regulator no longer approves new funds if they are identical in nature. Kapadia underlines the fact that at times NFOs are based on short-term fads or factors which may not play out in the longer term like specific theme-based funds which track short-term trends for certain sectors.

Both the financial experts have a word of caution for NFO investors. “First time investors should not invest in NFOs. Investment in NFOs should be part of a tactical portfolio and not a core one. For a core portfolio, investors should invest in existing performing schemes,” says Damodaran.

Similarly, Kapadia stresses the points that the core portion or long-term of one’s portfolio should be invested in funds with proven track record of over 5 to 10 year periods and perhaps a small portion can be invested in NFOs with differentiated strategies.

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This is because funds with proven track record tend to have an established process and investment strategy, which if maintained can be expected to generate consistent performance over the long-term, he says.

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